Capital investment and U.S. accounting and tax policies;

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Capital Investment and U.S. Accounting and Tax Policies
Richard D. Fitzgerald
Price Waterhouse & Co.
Capital formation is the lifeblood of our industrial and economic complex. Yet we hear increasing warnings of the problems ahead from undercapitalization of American business and the resulting constraints on production and employment.
Historical Background
For years, American business has been largely self-financing. Fifteen years ago, close to 90 per cent of corporate capital expenditure was supplied from internal cash flow—retained earnings and depreciation. This proportion has dropped significantly, although recently improved corporate earnings should help for the short term. We are all aware of the collapse in equity market financings in recent years. From a high point in 1972 of nearly $15 billion in equity offerings, there has been a dramatic decline in the last two years. The difficulty of raising equity capital on a reasonable basis has been accompanied by record levels of corporate indebtedness—an amount outstanding nearly as large as one year's GNP. Debt to equity ratios have risen sharply in the last decade. Of particular concern has been the marked increase in short-term indebtedness which requires continual refinancing.
One U.S. businessman has summarized his view of the basic capital problem:
The shortage of equity capital has been especially worrisome. This has forced us to rely on short-term and long-term debt to finance innova­tion,
modernization and expansion. Consequently, interest cost has be­come
a significant added expense, depressing profits. Lower profits make it more difficult to generate retained earnings. Lower earnings and a high debt to equity ratio further depress the value of the company's shares, making equity financing even more difficult.
While a number of studies have been made of the potential capital shortage, there are, as you might expect, as many different answers as there are studies. The New York Stock Exchange, in its often-quoted study of capital needs, has estimated a frightening shortage of savings compared to capital needs—$650 billion over the next ten years. Their study was based on projections of desired levels of investment and available savings under basic assumptions of 3.5 percent real growth and 5 percent inflation annually. Several other studies, such as Chase and Business Roundtable, also reflect shortages. The Brookings study,
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